Tax holidays: Do they create jobs?

Tax holidays can be a welcome allowance for some large multinational U.S.-based companies that store large amounts of cash overseas. Those companies tend to keep some of their cash offshore because they would have to pay a 35 percent tax on that money to bring it into the U.S.

But in 2004, companies got a break from this 35 percent tax. And now many of them are asking for another.

The American Jobs Creation Act of 2004 allowed companies to funnel their cash back into the U.S. but at a much smaller tax rate—only 5 percent. The purpose of the Act that gave companies this so-called tax holiday is right there in its name—to create jobs.

There was a catch, of course. Companies that took advantage of this tax holiday couldn’t just spend this cash as they pleased. They had to use it specifically on research and development, capital expenditures and pension funding. The law mandated that companies were prohibited from using it for shareholder dividends and share repurchases.

But according to a recent New York Times’ Dealbook post, tax policy experts aren’t so keen on tax holidays—at least, they have their concerns. Some have raised the question that while the stipulations under the 2004 Act are well-intentioned, there’s nothing to stop a company from allocating the funds it brings back into the country toward those purposes even if it would have allocated funds toward those purposes anyway—freeing up legitimate on-shore cash to use toward dividends and stock buybacks.

“If companies merely reshuffle the use of cash without changing behavior, then the tax holiday amounts to a windfall to shareholders, not an effective economic stimulus,” author Victor Fleischer, a University of San Diego law professor, said in his post.

A paper recently published by Northwestern University School of Law Professor Thomas J. Brennan about how companies used the cash they repatriated in 2004, he notes that for the 20 companies that brought back the most cash, they spent 78 cents of every dollar on permissible uses, and just 22 cents on impermissible shareholder payouts.

Brennan expanded that analysis to 341 companies outside the top 20and found that they spent about 40 cents of every dollar on impermissible shareholder payouts, still much lower than an earlier report that estimated 60 cents to 92 cents of every repatriated dollar from 2004 was spent on shareholder payouts.

According to Fleischer, the Brennan study is important because it explains how companies responded to the 2004 tax holiday, however, “it hardly endorses tax holidays as an instrument of international tax policy.”

And he points out further that there is no evidence the 2004 tax holiday created any jobs.